Kahlon's housing policy will boomerang

Prices may fall short term, but conditions are being created for steep rises later on, developer Eido Hagag argues.

It all started with Minister of Finance Moshe Kahlon's election platform, which had one main plank: lower housing prices. That was his political Archimedes lever. Pretty quickly, the minister realized that it wasn't happening, and he elegantly attempted to describe the fall in demand for housing and the decline in sales that he had engineered as an achievement. The fall in demand did indeed cause a slight price drop in the short term, but in the very near future it will lead to a substantial price rise and a worsening of the situation of Israeli homebuyers.

How did Kahlon do this? With a series of aggressive measures, he scared investors away from the market. He raised purchase tax, increased the amount of equity that an investor had to provide to 50%, tried, and failed, to impose a tax on anyone owning three or more residences, and, as if that were not enough, he turned anyone owning six or seven apartments or more into a target for investigation by the Tax Authority. One blow after another. In order to deliver the final coup, Kahlon declared again and again that home prices would fall, plummet, shrink. What investor would wish to put his money into the real estate market after all that?

I find Kahlon's pride in the fall in home sales hard to understand when in fact the consequences of it will be severe, as we shall shortly see.

Supply - A real estate project must at the outset sell a certain number of apartments in order to reduce the financial risk and in order to obtain bank finance. Pre-sales are generally to investors, who are prepared to buy an apartment in advance, but at a reduced price. By contrast, buyers of apartments to live in generally turn up at the later stages of the project and just before handover. Real estate developers who understand the new situation in the market and the fact that investor demand has diminished because of the minister of finance's policies, are choosing to wait with the land they have bought for better and less risky times.

Demand - Demand for homes in Israel will continue to grow for the usual reasons: natural population growth in Israel is higher than in most Western countries; the divorce rate is rising; Jewish immigration; and so on. The simplest and most basic principle in economics is that when supply shrinks and demand grows there can be only one result - prices rise.

If so, why has there been a short-term decline in prices? Existing projects hit by what has become known here as the "Kahlon offensive" are suffering from a halt in sales, which puts them in breach of their commitments to the banks to maintain sales at a certain rate. In order to avoid breaching his loan terms, a developer must cut prices to loss-making levels, or else he runs the risk of losing the project. Thus prices fall in the short term, but only in the short term, until the existing stock is exhausted. In the long term, because of a lack of supply and growing demand, prices will rise.

The Israeli economy has survived severe crises in the past to no small extent thanks to a flourishing local real estate market. When a home is sold, there are substantial transfers to the state: purchase tax, betterment tax, value added tax, income tax, development levies, and so on. Besides this enrichment of the public purse, the real estate sector provides livelihoods for thousands of tradespeople of various kinds. When the market stalls, these tradespeople are hit to the extent of layoffs and business closures. Those laid off will register at employment centers and demand unemployment benefits. Tax revenue will fall while welfare expenditure rises.

The Buyer Price problem

Kahlon boasts about the Buyer Price program, in which land is sold not to the highest bidder but to the bidder of the lowest price at which the apartments eventually built on the land will be sold. In practice, the method of land tenders according to a reduced apartment price fixed in advance brings in train several problems that ought to be considered.

The sale of land by tender at below market value amounts to under-selling of state assets, that is, our assets. We have lost money. Instead, a grant could be given to homebuyers. The state would still be losing money, but at least that would raise demand in the real estate market and provide work for all the tradespeople mentioned above.

The low price that some contractors undertook to meet in the Buyer Price program has brought them to a level of profitability bordering on losses. To minimize the damage, they have to cut the specification, to build to a low standard and at poor quality. These are not slogans; this is the reality. In some places where the program has been implemented we are seeing rickety buildings with cracked walls that will turn into slums.

Was there another way?

Had Kahlon promoted a law providing that a couple in their first years of marriage would be entitled to a grant of a few hundred thousand shekels in buying an apartment, he would have succeeded both in lowering costs and helping young people, and in maintaining demand and perhaps even increasing it, thus avoiding disruption to the market, boosting state revenues, and avoiding the unemployment that is on its way.

In the short term, prices will fall mainly in projects by contractors under financial pressure. In the not very distant future, prices will rise, and even soar, because of thin supply and growing demand. Unemployment will rise and Israel's economic strength will be undermined. None of these things is Kahlon's problem. He will shortly leave the Ministry of Finance for some other post, and will forget about housing, while we will be left to pick up the pieces and to face bitter consequences for years to come.